Letter from the Permanent Secretary, DETR, to the Chairman of the Committee (PAC 00-01/114)

SECTION 2 OFTHE CHANNEL TUNNEL RAIL LINK

Paragraphs 1.43-1.46 of the Comptroller and Auditor General's report on the Channel Tunnel Rail Link refer to issues over Section 2 of the Link. I thought the Committee might find helpful the attached brief summary of how we are proposing to take forward Section 2 of the project, as announced on 2 April.

I am copying this letter and the attachment to the Comptroller and Auditor General and to the other witnesses at your session on 9 April.

CTRL SECTION 2

INTRODUCTIONTHE 2001 DEALFOR SECTION 2

Following the restructuring of the original Channel Tunnel Rail Link deal in 1998, Railtrack committed to purchase Section 1 of the CTRL from London & Continental Railways (LCR)the company responsible for delivery of the link under the Development Agreement for the project between LCR and Government. As part of this arrangement, Railtrack took over management control of Union Railways (South), the LCR subsidiary responsible for the construction of Section 1. As well as taking eventual ownership of Section 1, Railtrack's key role was to bear the risk of construction costs over-running on that section by agreeing to purchase it for a price based on the actual cost of construction whereas the rate of return on its investment was based on a target cost.

Railtrack also took an option to take management control over the construction of Section 2 and to purchase Section 2 following completion, on a similar basis to the arrangements for Section 1. This option ran until 2003 but it was envisaged that Railtrack would exercise its option prior to the planned construction start date of July 2001.

In the event, Railtrack indicated that it would not exercise its option for Section 2 on the terms agreed in 1998 during 2001. The Government therefore asked LCR to develop further its alternative proposals for financing and sharing construction cost risk on Section 2, which it had been working up over the past year.

Under the deal announced on 2 April, Bechtel, a shareholder in LCR and a 52 per cent member of Rail Link Engineering (RLE, the project managers for CTRL construction), will increase its role in the project by taking a share of construction risk and arranging insurance for a further tranche of risk in return for a fee.

CONSTRUCTIONOF SECTION 2

Under the terms of the agreement, LCR will fund construction and, through its subsidiary Union Railways (North), remain the project client for the delivery of Section 2. As with Section 1, day-to-day project management of the construction works will be undertaken by RLE. The target cost for building Section 2 remains unchanged at £3.3 billion in outturn prices. Aside from its role in RLE, Bechtel has committed to bear a share of the risk of construction costs over-running the target cost and to arrange insurance to cover a further tranche of risk. In total these arrangements mean that around 60 per cent of the risk of construction

cost being up to £600 million over the target cost has been transferred to the private sector. LCR will retain the remaining 40 per cent of the risk of construction cost overruns; it will also bear the risk of inflation exceeding 3 per cent per annum. Ultimately these LCR risks are a Government exposure, through higher Government support to Eurostar over the longer term. The 95 per cent confidence estimates that have been produced for the cost of Section 2 are well below £3.9 billion (the target cost plus £600 million). The risk of cost overruns exceeding £600 million is therefore considered very small.

Upon completion, ownership of Section 2 will therefore remain with LCR but the intention is that it will be operated by Railtrack, and Railtrack will therefore retain a key role in construction in ensuring that Section 2 is built to the correct specifications for its eventual operation by Railtrack. To this end, Union Railways (North) will agree a Railway Services Agreement with Railtrack to cover the services it provides during the construction phase of the project. Railtrack will receive a fee for providing these services. Railtrack will also agree to continue to second certain staff to Section 2 in order to preserve continuity alongside its involvement in Section 1.

OPERATION

Although Railtrack will not own Section 2, it remains the logical choice to be the operator since it will own and operate Section 1, and is the sole operator of the domestic rail network. Under the new arrangements for Section 2, Railtrack will agree an Operator Contract to operate Section 2 for LCR. Operating arrangements for Section 1 will be revised to mirror the Section 2 structure. Railtrack will be in a position to operate both sections of the CTRL as a seamless railway and ensure a seamless interface with the national network for commuter services on the CTRL from Kent.

Under the terms of this contract Railtrack will be paid an annual fee, with the opportunity to earn bonus payments to incentivise high standards of performance.

FINANCING/PUBLIC SECTOR SUPPORT

The level of grants to be paid for Section 2 remains unchanged at £1.2 billion (1997 prices, discounted). The amount of further public sector support required by LCR depends on the performance of Eurostar, but it is expected to be no more (and most probably less) than if Railtrack had exercised its option. This is because Railtrack will no longer be paid the rate of return on Section 2 that would have remunerated it for the risks that it would have taken and its financing costs, if it had exercised its option. Eurostar's track access charges will accordingly be lower under the new arrangement, and LCR's need to call on public support will be correspondingly less. It is expected that this effect will outweigh any increased call on public support due to LCR's share of cost overruns.

LCR expects to fund Section 2 through a combination of Government Guaranteed Bonds (GGBs) and bank debt; work is continuing to optimise the financing plan. If Railtrack had exercised its option, the Section 2 GGBs would have been repaid out of the purchase consideration for Section 2. Under the new arrangement these GGBs would need to be repaid over a longer period, out of Eurostar revenues. Consideration will be given later this year to the best way of providing the necessary Government financial support for Section 2, to ensure value for money.

RAILTRACK'S OPTION

Once this agreement in principle has been transformed into legally binding agreements, and LCR has raised the necessary finance to construct Section 2, Railtrack has agreed to waive its option to purchase Section 2.